GDP rise is 'worrisome'

CBS.MarketWatch.com

NEW YORK (CBS.MW) -- Our indicators are still in neutral territory at 41.4 percent (a level below 30 percent is considered a bearish signal).

"The GDP rise is worrisome and it is the
largest gain since the fourth quarter of last year."
Elaine Garzarelli

With market indexes making new highs and bullish sentiment rising recently, a short-term pullback would be a buying opportunity as long as there is no recession on the horizon. Greenspan has raised interest rates preemptively to curb any inflation that may be creeping up.

However, if real gross domestic product growth and inflation do not subside, Greenspan would raise rates enough to create a slight recession as a harsh medication for the long-term health of the economy.

This week, the government raised its estimate of U.S. real GDP growth to 5.5 percent from their previous estimate of 4.8 percent primarily due to an accumulation of inventories and the GDP deflator was revised up from 0.9 to 1.1 percent. See story.

The GDP rise is worrisome and it is the largest gain since the fourth quarter of last year. The new era of strong productivity due to the technological boom, we believe, allows the economy to tolerate a potential GDP growth rate of 3.2 percent instead of 2.8 percent without triggering dangerous inflation. The problem, however, is that real GDP is growing at 5.5 percent.

Another rate hike likely

Another Fed tightening is probably likely if the stock market continues to boom and the economy does not slow. We believe most of this is already reflected in the over 6 percent long bond yield.

Over the long term, however, we continue to predict a level of 12,500 for the Dow and 1,600 for the S&P 500 by the year 2000 assuming the 10-year bond yield falls slightly below 5 percent (currently the yield 6.08 percent). This is based on an upwardly revised CPI inflation rate of 3 percent to 3.5 percent and a continued budget surplus.

Interest rate analysis

The bond market is not convinced that the Fed is finished raising rates. After a temporary decline in yields, rates have remained steady with the 10-year around 6.08 percent. We believe the bond market will rally when there are firm signs of slowing in the economy. Although our work shows, at this point, the equilibrium level of the 10-year bond is 4.7 to 5 percent, the bond market needs to see a number of consecutive signs of a slowdown before yields can safely trend down. We continue to hold on to bonds and buy at any rise in yields since we believe they will provide tremendous capital appreciation.

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